The Federal Reserve may need to signal a much more cautious outlook for interest rate cuts in the coming year as inflation creeps in and markets react to a host of uncertainties tied to President-elect Donald's administration. Trump.
Trump, who returned to the White House early last month, will begin the first half of his second term as president with narrow majorities in both houses of Congress and an ambitious economic agenda that he says will deliver massive growth and historic shrinkage. of the debt.
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“I think the economy is going to be very strong,” Trump told CNBC on Thursday during an interview following his ringing of the opening bell at the New York Stock Exchange. “We're going to do things that haven't really been done before. “We are going to reduce taxes even more.”
The stock market seems to agree: After its comeback, the S&P 500 surpassed the 6,000 point mark for the first time and the benchmark index is up about 6.3% since Election Day, adding more than $1.5 trillion to the collective value of the country's largest stocks. companies.
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However, investors are also starting to count the costs tied to some of Trump's proposals, including the wider budget deficits needed to pay for promised tax cuts, the labor market impact of his plans for the mass deportation of migrant workers and the additional inflationary pressures linked to his promise to raise tariffs.
Trump policies could fuel inflation
“There are many fiscal policy outcomes in the coming year that we lack clarity on, so it's increasingly difficult for us (and the Fed) to know where inflation is headed,” said Rick Rieder, director of BlackRock Global Fixed Income Investments.
“The Federal Reserve's policy calculus has changed materially since the election and the Fed is likely to communicate more aggressively through the updated Summary Economic Projections,” he added.
“In addition, (Federal Reserve Chair Jerome Powell) will likely discuss slowing the pace of rate cuts or pausing to determine how economic data will develop.”
Related: CPI inflation report raises bets on Fed interest rate cuts
The Federal Reserve's Summary Economic Projections, more commonly known as dot plots, are a collection of growth and inflation forecasts that Federal Reserve officials present each quarter and are published in chart form to indicate where they might be heading. interest rates.
The Federal Reserve will release a new round of projections next week as it concludes its two-day policy meeting in Washington with an expected quarter-point reduction in the benchmark federal funds rate.
In fact, markets are still convinced that the Federal Reserve will make its third rate cut of the year despite a faster-than-expected reading of producer price inflation and a pick-up in overall pressures on consumer prices. consumer in November.
New bets on interest rate cuts fading
From there, however, bets on future cuts are starting to fade, as inflation remains stubbornly high through the end of the year and the impact of the new administration's policies remains unclear.
CME Group's FedWatch, a real-time tracker of how traders view the Fed's rate moves in the near term, has locked in the chances of a quarter-point cut next week, while showing traders reducing their bets on further reductions in the second half of next year. year.
In fact, FedWatch suggests it's now a toss-up between one and two quarter-point cuts over the first six months of 2025, when just before the election the broader consensus was for at least three.
“This inflation figure is unlikely to derail the Fed's rate cut cycle, and we continue to expect the Fed to cut rates” by 0.25 percentage points at its December meeting, he said. Nathaniel Casey, investment strategist at wealth manager Evelyn Partners.
“However, we remain alert to any further deviation in the trajectory of inflation, given the resilience of the US economy and the potentially expansionary fiscal policy that could accompany the Trump presidency in January,” he added.
Related: Prepare for price increases if Trump's tariff plans become reality
Some of that concern is already playing out in the bond market, where investors ignored a robust auction of $39 billion in new 10-year bonds and focused on data showing a record $367 billion budget deficit. dollars for the month of November.
The benchmark security is now trading above 4.3%, a move that could increase the cost of servicing debt and serve as a warning to markets that investors are watching the path of government borrowing more closely than in the past.
That could play a huge role in Treasury repayment next year, as some $6 trillion in securities will mature during 2025, the most on record.
Budget Deficits Reach Record Levels and Widening
Adding in expected increases from a growing budget deficit, which is growing by $10 billion each day, the United States will need to find buyers for about $8 trillion in new debt next year.
Which brings us back to the Federal Reserve.
“While much attention is (rightly) focused on budget deficits and the amount of Treasury supply that will hit the market in the coming years, the primary driver of Treasury yields remains Fed policy,” he said. Lawrence Gillum, chief fixed income strategist at LPL Financiero.
Related: Analysts revise 2025 interest rate cut forecasts
“Our base case is that the Federal Reserve will take the (federal funds) rate to 3.75% in 2025. And after a few months of overly aggressive expectations, markets have generally adjusted their prices to be more in line with our expectations,” he added.
“Over the next 12 months, we see roughly equal upside and downside risks to yields as markets grapple with the true impacts of budget deficits, rising Treasury supply, and the extent of the current Treasury easing cycle. the Federal Reserve.”
More economic analysis:
- Trump Trade puts stocks at a record high. Where do we go from here?
- Fed inflation rises in October amid rising consumer spending
- Goldman Sachs analyst sees starting point for S&P 500's year-end rally
Signs from next week's Federal Reserve meeting will also be heard in the stock market, where analysts are forecasting another year of double-digit returns fueled by investments in ai, a resilient economy, strong consumer spending. consumers and lower interest rates from the Federal Reserve.
“Next week's Fed meeting is the next catalyst for markets, and while a rate cut is expected, the Fed will also provide guidance on its interest rate plans in 2025, which could help determine the stock's trajectory next year,” Clark said. Bellin, president and chief investment officer of Bellwether Wealth in Lincoln, Nebraska.
“The interest rate outlook is a bit uncertain for 2025 given the strength of the economy, and the Federal Reserve will have an opportunity to clarify its views on 2025.”
Related: Veteran Fund Manager Offers Alarming Forecast for the S&P 500
